Is Shiyue Daotian Group (HKG:9676) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shiyue Daotian Group Co., Ltd. (HKG:9676) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shiyue Daotian Group

What Is Shiyue Daotian Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shiyue Daotian Group had CN¥1.01b of debt in December 2023, down from CN¥2.78b, one year before. But on the other hand it also has CN¥1.44b in cash, leading to a CN¥426.0m net cash position.

How Strong Is Shiyue Daotian Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shiyue Daotian Group had liabilities of CN¥1.29b due within 12 months and liabilities of CN¥65.8m due beyond that. Offsetting this, it had CN¥1.44b in cash and CN¥461.5m in receivables that were due within 12 months. So it actually has CN¥547.3m more liquid assets than total liabilities.

This surplus suggests that Shiyue Daotian Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shiyue Daotian Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Shiyue Daotian Group turned things around in the last 12 months, delivering and EBIT of CN¥157m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shiyue Daotian Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shiyue Daotian Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, Shiyue Daotian Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shiyue Daotian Group has net cash of CN¥426.0m, as well as more liquid assets than liabilities. So we don't have any problem with Shiyue Daotian Group's use of debt. While Shiyue Daotian Group didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com